HE102/HE1002
Lecture 1 Introduction to Macroeconomics Deals with economy as a whole. Focuses on aggregate behaviors of all households and firms. #Aggregate Output: Fluctuations and Growth #Unemployment #Inflation 'Aggregate Output' Main measure of how the economy is doing. Fluctuations are shown by business cycles. In a business cycle, there are expansions and contractions. 2 consecutive quarters of contraction = recession. Prolonged recession = Depression. Measured by GDP (More concerned with location) GDP is the total market value of final goods and services produced within the country in a given period in time. Things excluded in GDP: Intermediate Goods- Final goods will already include the value of its parts Used/ Second-hand goods- Value would have already been counted in the past. Paper Transactions- No goods and services produced. GDP Calculations Expenditure Approach: Personal Consumption© + Gross Private Domestic Investment(I) + Government Consumption and Investment (G) + Net Exports (X-M) C: Durables, non-durables, services I: Non-Residential Investments, Residential Investments, Change in inventories G: Government expenditures and investments. Excludes transfer payments X: C,I,G does not include exports produced. Hence, have to add X M: C,I,G include imports that were not produced within the country. Hence, take away M *Do not use sales figure as GDP. GDP= Sales + Change in inventories Income Approach: Value-Added Approach: Sum up the value-added at each production process. Limitations of GDP Underground economy not reflected. Social Welfare not taken into account. Measured by GNP (More concerned with who owned the factors of production) GNP is the total market value of final goods and services produced by factors of production owned by country's citizen. GNP = GDP + (Net Income from abroad) Limitations GNP is difficult to compare across countries as exchange rates are always fluctuating. GNI is often used instead. GNI is GNP converted to a common average of exchange rates. 'Unemployment' % of labor force unemployed. Presence of unemployment seem to suggest perpetual disequilibrium in labor market. 'Inflation' Increase in overall price level. Hyperinflation is a period with very rapid increase in price level. Deflation is a decrease in overall price level. Prolonged deflation can damage the economy. 'Components of Macroeconomy' #Households #Firms #Government #Rest of the World Goods and Services Market Firms supply goods and services. Household provide demand. Money Market Households provide funds. Firms, government and rest of world engage in lending and borrowing. Labor Market Households provide supply of labour. Firms demand labor. 'History of Macroeconomics' Classical microeconomists conclude that markets generally work well. Markets always clear. Macroeconomists however, observe that prices are sometimes sticky. Prices do not adjust quickly to maintain equality between qty dd and ss. Microeconomic theories failed to explain the economic contractions and unemployment during Great Depression. Keynes' idea that it is not prices and wages that determine employment but aggregate dd started gaining traction. This suggested that government can influence output and unemployment. Hence, began the act of fine-tuning the economy. However, in 1970, Keynes' model cannot explain the stagflation situation. Since then, there is no agreed upon view of how macro economy works. Lecture 2 'Nominal GDP vs Real GDP' GDP measured in current dollars = Nominal GDP. Nominal GDP is calculated by (current qty x current price) As such, can be misled into thinking that production has grown when all that has happened is a rise in price. A better measure is Real GDP. Real GDP measures value of goods and services using base year prices. Change in Real GDP = Real GDP Growth Rate Limitations Real GDP depends on the choice of base year. 'Unemployment Rate' Ratio of unemployed to labor force. Labor Force = Employed + Unemployed. Population(16 yrs old and older) = Labor Force + Not in Labor Force. Labor Force Participation Rate = Labor Force/Population Discouraged Worker Effect People who cannot find jobs after a long time may become discouraged and stop finding jobs. People who are not looking for job or do not want a job is classified as not in labor force. These people fall out of unemployed and also the labor force. Unemployment rate and labor participation rate falls. Categories of Unemployment Frictional Unemployment: Due to normal working of economy. Caused by short-term job-skill matching problems Structural Unemployment: Due to structure of economy. Unemployment from sunset industries. Cyclical Unemployment: During recessions. Mainly what governments try to fight. Natural Rate of Unemployment: Unemployment that occurs as a normal part of an economy. Sum of Frictional and Structural unemployment. Usually about 4%. 'Inflation' Ways to measure Inflation: #% change in GDP Deflator #% change in CPI GDP Deflator of any year Deflator = Nominal GDP/Real GDP x 100 Inflation Rate = (Deflator this yr -Deflator last yr)/Deflator last yr Note: Deflator considers all goods and services CPI Considers only consumer goods and services. CPI may overstate inflation. It is a fixed weight index. It does not take into account substitution away from high priced goods. Hence CPI is upward biased. Implication is that social payments, which depends on inflation is higher than it should. Note: Producer Price Indexes measure the prices producers receive at all stages of production. It is a leading indicator of consumer prices. Cost of lnflation True cost of inflation is not the cutting of purchasing power. Because input prices tend to rise as well. Hence, income will rise too. Issue is whether income rises as fast as price increases. The true cost of inflation: *Expected Inflation Administrative Costs and Efficiencies High inflation means interest rates are high. The opportunity cost of holding cash is high. People will have to stop at the bank more often. People spend time speculating to beat inflation. The costs of expected inflation is likely to be small as firms and individuals will adjust. *Unexpected Inflation Distribution of Income Unexpected inflation can hurt creditors if contracts are not indexed to inflation.